By Andrew Ferguson, Managing Director, Buy-to-Let Mortgages
While the festive break may seem a distant memory now, it's still early enough in the year to ask: what is the biggest challenge facing landlords in 2023?
Ask that to a room of mortgage professionals and the discussion will still be in full flow as the lights are being turned off: never ending regulatory creep, a hostile tax regime, and costly energy-efficiency legislation are all major challenges.
However, there is an emerging issue which, for me, trumps all of these. That is, of course, the fallout effect of higher mortgage rates.
Unless you have been living under a rock, you will be all too aware how much mortgage rates have risen in the buy-to-let (BTL) sector over the past 12 months. A gloomy economic outlook, high inflation, base rate rises, the disastrous mini-Budget - these have all caused swap rates to spiral.
At the end of January last year, 2- and 5-year swaps were around 1.15% and 1.19% respectively. At the end of last month they stood at around 4% and 3.6%, although both are noticeably lower than they were in December.
As we know, swap rates directly influence fixed-rate pricing, and so the cost of borrowing has risen in tandem. According to data provider Moneyfacts, the average 60% loan-to-value (LTV) buy-to-let product was around 2.5% a year ago, whereas today it's more like 5.6%.
High-quality borrowers hit
This causes a raft of problems for landlords and, like I said, for me this is perhaps the biggest challenge problem landlords are facing at present.
Why? Well, because it is likely to cause many landlords to fall foul of lenders' debt service coverage ratio (DSCR) criteria .
The issue is that rents have failed to keep pace with the rise in mortgage with the rise in mortgage rates, and so landlords in low-yielding areas are unable to pass in the additional cost onto tenants. If landlords can't charge higher rents, they may not be able to borrow as much, because they cannot pass lenders' DSCR requirements.
As a result, there will be a raft of high-quality borrowers out there at the moment who will find it difficult or impossible to refinance at the same level of leverage they did a few years ago.
The only two options these landlords have is either to move onto their existing lender's pricey reversion rate, or stump up extra cash to get the purchase or remortgage over the line.
That is fine if you are a wealthier landlord with a large property portfolio, but what about those who are using their one or two property portfolio as their pension? In effect, they become mortgage prisoners.
Thankfully, there are a couple of levers to lenders that allow them to continue lending to borrowers in this position.
Flexible and innovate
The first is taking a more flexible approach to the DSCR itself. West One, for example. has recently launched a series of limited edition deals where the interest cover ratio (ICR) is 100%, instead of 125% or more.
You may ask yourself if this is a wise, and of course, this is not a mass market option. But for high-quality borrowers with good long-term track records, it can be a low risk solution.
For that reason, I expect we will not see mainstream lenders adopt this approach. Instead, it will be specialist lenders, which offer bespoke underwriting and are more tolerant to risk.
The second thing lenders can do is become more flexible with their rate and fee options.
For years, the standard buy-to-let mortgage arrangement fee has been around 2%, particularly in the specialist end of the market. However, what if lenders were instead to charge a lower rate but higher fee, of, say, 5%? That way, the borrower has a better chance of getting the leverage they need.
One of the benefits to lenders is that the approach is entirely flexible, and the rate or fee can be set at such a level they don't lose money.
We're in a very difficult phase in the economic cycle, and so, landlords will need plenty of support from the lender community. It's important, therefore, that lenders innovate sensibly to ease a bit of pressure.
As the old saying goes: in the midst of every crisis, lies great opportunity. For us, that opportunity is to innovate.